- CFA Exams
- CFA Level I Exam
- Study Session 7. Financial Reporting and Analysis (2)
- Reading 21. Understanding Income Statements
- Subject 7. Earnings per Share
CFA Practice Question
All of the following securities may affect the numerator in the basic EPS equation EXCEPT ______.
A. options
B. restricted warrants
C. convertible preferred stocks or convertible bonds
Explanation: Options only affect the denominator in the basic EPS equation because option exercise has no impact on earnings available to the common shareholder. Warrants may affect the numerator if the proceeds generated via exercise are restricted to the retirement of debt, which will reduce the firm's interest expense and thus increase available earnings. If convertible preferred stock is dilutive, the convertible preferred dividends must be added back to earnings. If convertible bonds are dilutive, then interest expense x (1-t) is added back to the numerator.
User Contributed Comments 6
| User | Comment |
|---|---|
| BZZNone | Did you mean diluted EPS here? |
| Melle | They must mean diluted EPS, otherwise this question doesn't make any sense. |
| Heman | The question is correct. They are asking what impact would there be to the numerator of the 'Basic EPS equation' in order to calculate the dilutive effect on EPS resulting from the securities listed. As explained above, options do not impact the numerator of the basic EPS equation in order to calculate the dilutive effects. However the others do. Must admit the question threw me as well. |
| najat | It took me a while to understand but I think they don't actually mean what role "in the basic EPS equation options, restricted warrants, convertible preferred stocks or convertible bonds might have" The question is about their impact on the numerator, which is Net income available to common shareholders. They can have an impact on Net income, but are not taken into account in the basic EPS equation. |
| rjdelong | Actually it is the basic EPS equation thay are referring to here not dilutive. The difference between basic and dilutive is in whether the actions are taken during the year or COULD be taken during the year. The dilutive EPS is showing what eps WOULD BE IF options, warrants, convertibles were exercised, whereas the basic eps is showing what eps ARE considering that these options, warrants, convertibles WERE actually exercises. In essence Dilutive eps is asking for hypothetical whereas Basic eps is asking for what actually is now. |
| ascruggs92 | ^That's a confusing but correct explanation. Basic EPS is calculated using current outstanding share count. Diluted EPS is calculated using Basic share count plus all in the money options and warrants (out of the money ones wouldn't be exercised) net of what can be bought back with the proceeds from exercising. This is a bit confusing because stock options granted to executives are called stock options generally, but they are technically warrants. Options traded on exchanges have no effect because those shares are outstanding and already included in the basic share count |